Gaming the Giants: How Startups Shape Innovation to Spark Acquisition Wars

Özlem Bedre Defolie, Gary Biglaiser and Bruno Jullien
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Özlem Bedre Defolie: EUI - European University Institute - Institut Universitaire Européen
Gary Biglaiser: UNC - University of North Carolina System
Bruno Jullien: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse

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Abstract: We study a startup's choice of its "direction of innovation," how well the technology fits alternative acquirers, and the effects on acquisition outcomes and market dominance. Two horizontally differentiated firms bid to acquire the innovation and then compete in the product market. Firms differ in initial quality stock and in "absorption capabilities," how effectively the acquired innovation is integrated into their stock. The innovator designs the innovation to intensify bidding by putting firms on a more equal footing, thereby favoring the initially lower-quality firm. As a result, "increasing dominance" is less likely than under exogenous fit. The winner of the innovation is driven primarily by relative absorption capabilities rather than initial quality: the f irm with higher absorption capability is more likely to win. The equilibrium innovation direction minimizes industry profit and consumer surplus. In a two-period model, decreasing dominance becomes more likely when the low-quality firm has stronger absorption capabilities.

Date: 2026-04
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